It came as a shock to most but the United Kingdom has voted to leave the European Union. Everyone wants to know what happens from here but the harsh truth is no one knows for sure. No country has ever left the European Union before so there isn’t a playbook for such an event. Markets hate uncertainty and right now there is a mass of uncertainty about the future which isn’t likely to be resolved anytime soon.
For long term investors this really shouldn’t change anything about your approach if you’ve properly assessed your tolerance for risk and time horizon. It’s in times like these when investors find out if they have the correct plan in place. If you panicked on Friday and made any substantial changes to your portfolio, your doing it wrong. While there is no way to take all of the emotions out of it, after all no one enjoys seeing the value of their investment accounts go down, an investor with a properly created investment plan tailored to ones risk tolerance and time horizon should result in an investor who isn’t swayed into making any significant changes to their portfolio during these types of events. However this isn’t easy, so if your having trouble then find an independent fee only investment adviser to help you navigate the waters.
In light of Fridays price action let’s take a step back and examine the facts.
Although Fridays drop of 600 points sounds scary, the market had been going up all week prior to the referendum, including up 250 points on Thursday. So the net decline in the Dow for the week was actually only 274 points or 1.5%.
For the S&P 500 the total decline for the week was 33 points or 1.63%. Not great of course but not horrible either.
The results of the vote means that the UK will now enter into a period of negotiations with the European Union in regards to the future trade policies and relations. At this point the UK will continue to remain a full member of the EU during the negotiations which could take 2 years or more to complete. What this means is that this result is probably not quite as disruptive as the financial media will lead you to believe, at least in terms of the political process.
Also the UK accounts for 3% of global GDP and about 2.9% of revenues for S&P 500 companies. So the effects of the UK disruptions on the domestic market are negligible. I know there are many additional moving parts such as the currency and bond market ramifications, but the purpose of this post is simplicity and focusing on the facts instead of predictions.
The last point is the case for diversification. Friday was the perfect example why investors should still have allocations to bond funds. I know bonds are boring and interest rates are at all time lows. But it’s in times like these, when investors need them the most, when bonds have generally provided a form of insurance against market big declines. An investor with a bond allocation softened the blow of Friday’s price action and likely kept them from making an emotional decision.
The long term US treasury bond index fund (TLT) closed up 2.68% on Friday after being up as much as 3.5% at the open. This is the perfect example why investors should not give up on high quality bonds of all duration’s, especially as this current bull market eclipses the seven year mark.
In conclusion investors will no doubt be bombarded with a plethora of opinions and predictions. We really don’t know how this will all play out and that will likely effect asset prices, especially if earnings growth for the second half of the year fails to materialize. Add in the fact that the US has it’s own election this year and you have a recipe for heightened volatility. We may not know the outcome with any certainty, but eventually the smoke will clear and the markets will resume their uptrend. In the meantime stay diversified.